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The malls are filled with people shopping for the coming holidays. While the natural inclination would be to expect the big winners of this shopping season to be the major brick and mortar retailers. In reality, eBay (EBAY) may actually be the big winner this holiday season. And the reason is not what you would normally think. So what is eBay's not-so-secret weapon? PayPal. PayPal is a cash cow for eBay and will be the engine for eBay's revenue growth for the foreseeable future. Why is PayPal so important? Because mobile payments are becoming the wave of the future and PayPal is already proving it is more than ready to be the big boy on the block.

PayPal's Profitability

PayPal is already incredibly profitable. In eBay's third quarter, PayPal's revenue reached $1.4 billion and its total payment volume grew to $35.2 billion. That represents a 24% increase in PayPal's revenue and made up 41.1% of eBay's Q3 total revenue. Those numbers are staggering. By the end of fiscal year 2012, eBay expects over $10 billion in mobile payments alone. PayPal also has very healthy merchant transaction margins of 64.8%.

PayPal is obviously still growing. According to the Q3 conference call, PayPal had 117 million active users with account growth accelerating by 1% to 14% in Q3. Remember, these numbers were before the holiday shopping season. The most recent numbers from eBay reports that PayPal saw an increase in mobile payments of 133% during Thanksgiving Day, 153% on Black Friday, and 196% on Cyber Monday. Consumers are not just doing their holiday shopping using their credit cards but are using PayPal for mobile payments.

EBAY's PayPal is well Positioned to Dominate the Mobile Payments Market

The mobile payments market is expected to grow from $240 billion to $640 billion by 2015. This growing market is already attracting the attention of Square Inc., Intuit (INTU), and financial institutions such as Bank of America (BAC). With the potential growth in the market, competition is building and PayPal is well positioned to dominate the mobile payments space.

The reasons PayPal is well positioned to benefit from the growth of mobile payments have a lot to do with what banks call "share of wallet". Share of wallet is a term used by retail banks when discussing the cost to their customers to switch banks. Many retail bank customers will endure high fees and dissatisfaction with their bank due to the number of products and services they have with the bank. For example, if a customer has a checking account, direct deposit, a car loan, and credit card with a bank, the customer would rather just stay with that bank than try to move all those products to a new bank. As mentioned before, PayPal has 117 million active users. If these users use PayPal for the mobile and online purchases as well as their Bill Me Later service, customers may find it easier to stay with PayPal instead of switching.

Share of wallet does not just apply to personal accounts but also business accounts. Many of the 117 million users were small online businesses that use PayPal as their payment processor. PayPal is not satisfied with just small businesses. In Q3, eBay reported 10 major retailers who have PayPal live in over 7,000 locations. That number is expected to grow to 20 major retailers using PayPal for their point-of-sale operations by the end 2012. EBay also entered into a strategic partnership with Discover (DFS) which would give them access to over 7 million merchant locations in the U.S. by next spring. All this leads to more businesses seeing PayPal as an important part of their day-to-day operations. Many of these businesses would see switching to another payment processor as an unneeded hassle or cost.

The share of wallet concept becomes far important when you consider the fact that PayPal is dedicated to innovation and growing PayPal. Currently PayPal is spread over 9 product operations. EBAY has decided to consolidate all these operations into one product operation. This would allow PayPal to become even more profitable as overhead and other expenses are reduced. This will also increase innovation as less bureaucracy will encourage communication and problem solving. The move toward innovation is evident in PayPal labs where the company states their mission is, "trying to rapidly bring significant benefits to our customers and partners through quality research, collaboration, and innovation". The PayPal labs approach is reminiscent of Google Labs. If PayPal is able to create compelling products and services that expands share of wallet, PayPal may create an incredibly large barrier to entry for any competitors who are late to the game.

Another reason PayPal is well positioned to dominate the mobile payments space has a lot to do with the Dodd-Frank financial reform bill. PayPal's greatest threat is that of large financial institutions crowding them out of the mobile payments market before they are able to solidify a large enough market share. Fortunate for PayPal, the liquidity risks many financial institutions are facing due to the uncertainty created by the new regulations have made many financial institutions hesitant to expand operations. Many large financial institutions are still waiting for aspects, such as the Volker Rule, to be written and interpreted. Because PayPal is not considered a large financial institution, it will avoid most of the effects of Dodd-Frank in its current state.

Risks Facing PayPal

While PayPal is well positioned to greatly benefit from the growth of mobile payments, it still faces some risks to its business. The largest risk has to do with future regulations. At the moment PayPal is largely unaffected by the bulk of Dodd-Frank. This does not mean it will always continue to be this way. If regulators turn their attention toward mobile and online payments, PayPal may have to change large aspects of its business model. PayPal has taken a proactive approach in trying to conform to many financial regulations that deal with electronic payments. However, some of the issues they have faced in California reveal the risks PayPal is exposed to when it comes to regulation.

Another risk is PayPal's ability to innovate. If PayPal's consolidation does not produce the hoped for synergies fast enough, the dominance of PayPal may be short lived. PayPal does have serious competition from Square Inc., Intuit, and Google Wallet (GOOG). However, Square Inc. has shown that it is serious about competing against PayPal with its Starbucks (SBUX) partnership. Also, some financial institutions are starting to wade into the mobile payments water, despite the current regulatory uncertainty. The most noticeable financial institution is Bank of America which will launch its mobile payments program in December. If PayPal is not quick enough in innovating and expanding its mobile payments operations, it could quickly be overtaken.

PayPal Could Equal Serious Profits for Investors

EBay's PayPal will continue to be the revenue generator it has been for the past few years. In fact, there is a case to be made that EBAY's continued growth can be directly tied to the growth of PayPal. Investors should give EBAY serious consideration when looking for a way to benefit from this holiday season and the growth of mobile payments. Any weakness may be a great time to buy.

Source: How eBay's PayPal Is The Next Big Gift For Investors